Last week we talked about dollar-cost-averaging and compounding interest, two investment strategies that require setting aside emotions and riding the rollercoaster of the changing market. With these two, investors must avoid the fear of fluctuations and decide to be in it for the long haul. Buy and hold works much the same.
The logistics of it are just as they sound; buy stocks and hold them. Easy, right? Well, just like we said last week, pessimism is easier than anything else. It’s normal for investors to see a drop in their stocks and feel the urge to take their money and run. This emotional reaction to the moving market is a surefire way to burn through your money and your portfolio. Rather than run away, buy and hold encourages investors to stay still. Hold on to what you purchased (even if it's with shaky hands) and remain optimistic that the market will move up again. (Spoiler alert, it probably will).
Active Vs. Passive Investing
Buy and hold is considered a passive investing strategy. This is because rather than actively manipulating the investment according to the market, the funds under a buy and hold method will not be touched. Instead, bought and held investments would be left alone over long periods of time. Passive approaches such as this are frequently used, given how difficult it is to predict market fluctuations accurately. Often, investors make the wrong predictions regarding their stocks’ future performance. Trying to outsmart the market's mood swings is about as easy as outsmarting a teenager's mood swings (AKA, not easy at all).
So, what do we do with a moody teenager? We leave them alone and let them blast bad music from their bedroom. A similar approach is taken with buy and hold, except you can leave your stocks alone, and they won’t play a bad teenage rage album in your home. Win-win.
All jokes aside, passive investment strategies have been a well-respected investment model among financial advisors because it follows that golden rule of ruling out emotions when managing your finances. Allowing your stocks time to sit also allows them time to grow, and pulling out at the first sign of trouble could mean committing to a loss while missing a potential gain in the future. Let’s give you an example:
The Long Haul
Money doesn’t grow on trees, but it does grow like trees: slowly but surely. If you cut down your stocks before they have time to form fully, you could be stuck with a Charlie Brown Christmas tree of malnourished investments. One popular example of investors who kick themselves for kicking out their stocks too soon is the case of Apple stock in the early 2000s. If you’re reading this on a Mac computer or an iPhone, you might feel a bit spiteful knowing that shares of their company once ran for $18. In 2019, you can get a share for around $157. Before you throw your thousand-dollar phone at the wall, imagine how investors who decided to sell their stocks fell. Those who waited could cash out, but those who lacked patience probably lost out on a great opportunity.
Risk vs. Reward
To be fair, there are times when ditching your stocks might prove more rewarding than holding on. After all, not every company is the next Apple. And distinguishing between what will be a successful investment vs. what will be an unsuccessful investment is like distinguishing between apples and oranges. Both look good, but which one’s rotten?
Well, you can find out by biting into it. Deciding to sell your stocks when you assume they will make the most gains is enticing. Actively taking a chunk out of your shares is like biting into the apple before it gets too old, but what if waiting for it to ripen would make it sweeter? That is the risk of active investing. Buying and holding stocks is a much more stable way of determining whether or not your stock is a good or bad seed. By waiting a long enough period of time, you can make a realistic estimate as to whether or not the value of your investment will grow and, therefore, make a more informed decision about what to keep and what to kick.
Moral of the Story
At the end of the day, the market goes up more than it goes down. Fluctuation fear can often encourage us to drop our stocks, but it's important to remember that the market is not some big, bad monster. It’s just a moody teenager. Okay, to be fair, that sounds just as scary - but not nearly as dangerous. Holding on to our stocks and allowing them time to grow, evolve, and discover their true value will often lead to greater, safer returns than if we choose to run away.
Stay tuned for Part 3!
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes.
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